The Current (Altered) State Of Monetary Policy

The Global Financial Crisis - and importantly, a number of key developments emanating?from it - drastically changed how the Fed implements monetary policy.? And that difference is important for investors of all stripes to understand when thinking about possible Fed actions going?forward.?

Prior to the GFC, operating under?what is now referred to as a 'scarce' bank reserve framework, the Fed implemented?policy mostly by altering the Fed Funds Rate (FFR) through the buying/selling of Government securities in the open market... so as to tweak the limited supply of bank reserves.? This caused the FFR to shift up/down, requiring relatively small amounts of Fed intervention.? ?Seems almost quaint these?days.

As the GFC (and attendant policy reactions) devolved, the Fed was forced to operate initially in a financial system jammed-full of what they are now calling 'abundant' reserves -- which, thanks to QT, has been further rebranded into an 'ample' reserve framework...? where the FFR is bounded within the interest rate guardrails established by the rate the Fed pays banks to hold reserves (IORB), and - with a nod to the non-banks - the rate it pays to (mostly) Money Market Funds for Reverse Repurchase Agreements (RRP).? And as I've said before, the amount of 'excess' reserves in the system -- a largely theoretic notion at this point -- when added to the amount of RRP outstanding, is a good place to start when attempting to conceptualize how much more policy-induced liquidity remains sloshing around the system than should be.

But let's stop here and take stock: essentially, the FFR used to be set by tweaking the rate that banks charged?each other to borrow/lend bank reserves (i.e., the banks pay each other; the Fed tweaks the rate).? The GFC/ZIRP/QE - along with a couple Treasury/funding market seizures -? essentially blew-up that construct.? So now, the FFR is set by the rates the Fed pays?banks and MMFs (which is effectively printing money) to hold all the liquidity that policymakers overly-injected into the system in the first place.

Think about that...?the Fed?is paying a relatively steep rate of interest to the storage facilities?that house all the excess liquidity still sloshing around out there.? Sure, QT is slowly soaking up some of that excess liquidity... but Janet Yellin is doing her damndest to offset it.? While some at the Fed are doing good work actively contemplating how to soft-land the QT liquidity-soaking program, the effort is hugely complicated by Yellin's counter-cyclical, politically-tinged version of QE (yes, that's an "E"... not "T").??

All-in-all, though, as monetary policy metastasized from (i) scarce to (ii) abundant to (iii) ample reserves, I tend to view the Fed's "explanations" as simply an attempt to rationalize their (re)actions, as well as an effort to reframe economic history to fit the current absurdity.? Let's not forget: the only reason there's?a boat-load of excess reserves (still) in the system is because our policymakers put them there in the first place... and are paying?handsomely as they remain. ?But I suppose we'll have to wait to see how history actually looks back at this period.? Not well, is my guess.?

Anyway, I find it fascinating to watch the Fed trying to deal with (and explain away) why?all that cheap money -- accumulated over the last 15-ish years -- ultimately ended up as reserves or in MMFs.? A slew of jargon-y academic papers have chronicled these changes in how monetary policy is implemented.? I'm particularly impressed by the work of Lorie Logan at the Dallas Fed, who seems to have the best handle on things.? But be clear: the?Fed is now saying the quiet part out loud.? They're openly admitting that all?that money was created in an attempt to manipulate the markets first?-- and then, by extension, the economy second -- via 'the wealth effect' (which, unfortunately, neither theory?nor practice lends much support to its effectiveness).? This is an inherently dangerous game... especially when using untested new tools.??

I'm concerned that operating in an abundant/ample reserve system could tend to actually?increase monetary lags... the time it takes for policy changes to ultimately impact?the economy.? This is because, instead of operating in the steepest, most sensitive?part of the reserve supply curve (as was the case under the scarce reserve framework), today's new IORB/RRP corridor?targets the flat-ish, less sensitive portion of the curve.? Plus it requires significantly larger (and far more costly) tweaks by policymakers.? I'd prefer less.? It wouldn't be too much of a stretch to suggest that operating in an 'ample' reserve framework makes monetary policy an even blunter tool?than it was in the old regime.

Perhaps that is why policymakers?are spending so much time/effort confusing the hell out of everyone with their incessant 'forward?guidance' babble, in the theory (hope) that it helps reduce the added lag introduced by the new abundant/ample reserve framework... which, frankly, amounts to perfectly whacky circular reasoning.? [Side note: I remember being at an?'off-the-record'?meeting with Powell's alleged hero Paul Volcker, when Volcker explained he preferred leaving the market with a touch of 'constructive uncertainty' about the Fed's next moves.? He felt it discouraged the most leveraged/speculative elements from poisoning the system.? Again, how quaint that now seems.]

But really, this whole construct?sucks...?its logic fails at almost every theoretic assumption point.? It smacks of a Rube Goldberg?rationalization of simply horrible, reactive, post-GFC policy... as opposed to a proactive/systematic, real-world approach where monetary measures are directly aligned with targeted measures of economic output.

Oh, and one last thing thing for us to chew on during this likely-contentious election year: Former Fed Chair - now Treasury Secretary - Janet Yellin certainly has a good understanding of how this new monetary framework works (hell, she helped build the beast), and has already proven she knows which fiscal levers to pull to further her political agenda:? "Gee, let's see: increased deficits => added liquidity (reserves) => stimulation via the wealth effect => markets go up => economy goes up => reelection... Yay, ample reserves''.??

Just what we need; politicized, backdoor monetary policy.